Inside Third Avenue Management, where employees were terrified to bring bad news to the boss

BOSTON — In the months before the blowup of Third Avenue's
junk-bond fund in early December, investors and financial
advisers called the New York-based investment company to voice
their concerns about the growing percentage of hard-to-trade,
illiquid assets in the fund's portfolio.

"I would call up and they would say, 'We're under control, we
have plenty of cash,'" said Richard Berse, president of Northstar
Financial Advisors Inc. in New Jersey. But Berse, who had as much
as $2.5 million in client money in the fund, got burned.

Less than a month after his last call to Third Avenue Management
LLC, the $789 million Focused Credit Fund abruptly blocked
investor withdrawals and announced on December 9 it would
liquidate the fund's assets.

The extent of the losses are unclear.

Brad Alford, chief investment officer of Alpha Capital Management
in Atlanta, also said he told Third Avenue the fund was too
volatile because it was holding too much in illiquid assets. "I
just became very uncomfortable with it," said Alford, who pulled
out of the fund this summer.

The biggest mutual-fund blowup since the 2008 financial crisis
underscores how difficult it can be to rein in a mutual fund
taking outsize risks compared with its peers, even though Focused
Credit officially had many overseers. The US Securities and
Exchange Commission, which is investigating the fund's meltdown,
did not get involved until it was clear Third Avenue's only
recourse was to liquidate the fund, according to people familiar
with the situation.

Executives at Third Avenue and its parent company, Affiliated
Managers Group Inc., declined to comment or did not respond to
several requests to comment for this story.

When compared with other junk-bond funds, Focused Credit carried
an elevated amount of risk. The fund disclosed, for example, that
its so-called Level 3 assets, or securities that are hard to
value and trade, were 20% of assets at the end of July. That was
higher than at any other US junk bond fund with at least $500
million in assets, according to a Reuters analysis of fund
disclosures.

And the fund had 76% of its portfolio exposed to very low-rated
"CCC+" rated securities and below, compared with a median level
of 22% among similar junk funds, according to analysts at
Citigroup. Launched in 2009, Focused Credit found its way into
the portfolios of mom-and-pop investors, pension plans, and
nonprofits, fund disclosures show. It differed from other
junk-bond funds because it favored creditor claims and stock
warrants tied to companies going through bankruptcy.

One of its biggest investors was the Boston-based Fidelity
Investments' Strategic Advisers Income Opportunities Fund, which
had a $128 million stake at the end of October. Fidelity declined
to comment on the fund's current exposure.

Graystone Consulting, Morgan Stanley's independent adviser to
institutional and wealthy clients, originally recommended the
fund in 2014 via a due diligence report that clearly highlighted
the fund's liquidity risks, Morgan Stanley spokesman James
Wiggins said. Graystone then produced an updated assessment in
2015 in which liquidity risk is also highlighted, he added.
"Graystone stands behind its review process. Third Avenue has a
strong track record as an investment manager and has found
historical success in illiquid instruments," Wiggins said.

Blunt and autocratic

Third Avenue, led by long-time chief executive David Barse, did
not recognize the danger the fund was in until it was too late.
In fact, fund management team members discussed internally that
they believed the fund still could ride out a storm of
redemptions less than 90 days before the fund's collapse, said
former and current employees who requested anonymity.

Inside Third Avenue, some of the company's 100 or so employees
were unsettled by Barse's management style, which they saw as
blunt and autocratic, according to interviews with about a dozen
former and current Third Avenue employees. Perhaps most
important, Barse's hard-charging personality made it hard for
subordinates to bring him bad news, these sources said. In recent
years, some even complained to AMG, the parent company of Third
Avenue, but Barse, who had led the firm more than two decades,
remained firmly in control.

Barse sometimes berated employees in front of colleagues,
reducing them to tears, according to the current and former
employees. In the months before Focused Credit's collapse, key
people jumped ship as the fund hemorrhaged assets, declining to
less than $1 billion from more than $3 billion in 2014. Three
members of Focused Credit's eight-member team, for example, left
during the first half of 2015, according to current and former
Third Avenue employees.

Barse, 53, did not return messages seeking comment.

He made a positive impression in some circles. Barse is a trustee
of Brooklyn Law School, from which he graduated in 1987. The
chair of the school's board, Stuart Subotnick, said he didn't
know what to make of the criticism. "David is a tough guy. I
would imagine there are a lot of guys in that business who are
jealous of him or don't like him, and this was an opportunity to
dump on him," Subotnick said.

AMG chairman Sean Healey, who declined comment for this story
through a spokeswoman, personally got involved in the discussions
that led to what the two sides ultimately described as Barse's
mutually agreed departure from the firm after the junk-bond
fund's demise, according to people familiar with the situation.

Under Barse's direction, assets at Third Avenue peaked at $26
billion in 2006, but by the time of his departure managed assets
had dwindled to about $8 billion. And investment advisory fees at
the firm's flagship Value Fund were just $22 million in the
fiscal year that ended October 31, 2014, down 77% from $97.2
million in fiscal 2007, fund disclosures show. "I hope you
appreciate that David and everything he stood for are being
disassociated from the fund," said Martin Shubik, an 89-year-old
Yale University economist who is an independent director for the
Focused Credit Fund.

Five of the fund's six other independent directors did not return
messages or referred questions to Jim Hall, Third Avenue's
general counsel, Hall did not return messages seeking comment.
The sixth director could not be reached.

Dean of distressed investing

The board charged with oversight of Third Avenue's five mutual
funds, including Focused Credit, largely allowed Barse and his
top lieutenants to run operations as they saw fit. That's
according to past and current employees who had direct knowledge
of interactions between Barse's team and independent fund board
directors.

Some mutual-fund experts criticize outside directors, in general,
for not challenging investment-company management teams. It's not
uncommon, for example, for some directors at large mutual-fund
companies to sit on the boards of dozens of funds and to receive
fees from each in what critics call a cozy rubber-stamping
operation for management. "People know what side their bread is
buttered on," said Alan Palmiter, a Wake Forest University
professor who studies the fund industry.

Founded in 1986 by Martin Whitman, now 91, Third Avenue prides
itself on finding deep value in beaten-up securities. "Cheap and
safe" is the company's guiding principle. Whitman, considered the
dean of American distressed investing, remains chairman and a
portfolio manager at Third Avenue. He did not return messages
seeking comment. Whitman, Barse, and other top executives sold
their controlling stake to AMG in 2002. But day-to-day operations
did not change. A cornerstone of AMG's approach is operational
autonomy and independence, allowing principals such as Barse to
run fund operations.

"That's their business model and if they change it, no one would
ever sell to them again," said billionaire investor Mario
Gabelli, who founded the fund-management firm Gamco in 1977.